Higher profits come at a cost. Be careful what you wish for.
As a multiple-decade veteran of Big Law, I vividly remember the many debates about whether practicing law was a profession or a business. I was often leading these discussions as the firm-wide managing partner of operations of a global law firm. How could a firm with over 1,000 lawyers, over $1 billion in revenue, and over 20 offices be anything but a business?
In an attempt to gain the latest insights on strategy, finance, human resources, outsourcing, and IT, I eagerly read every issue of Harvard Business Review. I remember years ago having to overcome the partners’ resistance to being paid only by direct deposit and to increasing the partner-to-secretary ratio beyond 1-to-1. Now that I am gone from Big Law and managing a law-school legal clinic where I am still practicing law (but with startups and other micro businesses), I frequently question whether being so focused on productivity and efficiency in my former life was worth the price. Perhaps giving up a few ticks in profits per partner (PPP) would have made my firm a better place.
In this Labor Day essay, I’ll offer some second thoughts on the business of law, not necessarily offering any conclusions on best practices, as each law firm partnership gets to (must) make their own tradeoffs. Instead, I’ll cycle through six examples of how a laser-like focus on higher profits has done significant damage to what is good and enjoyable about the practice of law. Indeed, unless the pendulum swings back to the other direction, we may be headed to our own Norma Rae moment.
Example 1: Dropping lower-profit practices and clients
Law-firm partners often presume that all practices are equal from a profitability standpoint. This is far from the truth.
Even if work were billed out and collected at the same hourly rates with no discounts, numerous factors impact the profitability of particular practice areas and projects, including leverage (generally viewed as the ratio of partner time to non-partner time on a project) and the cost structure for the team doing the work (e.g., different metropolitan areas have much different costs for such items as rent and support staff). The harsh reality is that certain practice areas, such as trusts and estates and patent prosecution, are often “partner heavy” and, therefore, less profitable than a big litigation case or a major M & A deal that has a large team with many non-partner lawyers.
There are also certain types of clients, such as hospitals, universities, and other non-profit institutions, that despite being large prominent organizations, frequently cannot justify paying “full freight” for professional services. Every city has certain non-profit institutions that are visible pillars of the community, and, therefore, there is always a competent law firm that is willing to do their work at discounted rates.
From a profitability standpoint, doing low-leverage or other lower-profit work and representing non-profit institutions, as just two examples, would be dilutive to a firm’s published PPP. For a firm that worships at the altar of the PPP god (which includes most of Big Law), it makes sense to tell the partners in the pertinent practices that “you would be happier at a different firm.” Of course, a firm could just pay less to the partners doing this work or representing these clients, but that would still dilute overall PPP.
Example 2: Dropping plateaued partners
Big law firms are quick to sing “we are family” on their websites, but when it comes to mid-career partners who have not developed their own client base or who are not practicing in an important niche area, such as tax, firms often decide that it is time to stop the music and break up the family.
The break-up is prudent from a financial point of view because the firm could probably provide the same services but at a cheaper compensation level with a more junior partner (similar to the way that corporate America offers mid-level—but stalled–managers “a package” to leave). Unfortunately, when these partners are encouraged to move on, they seldom get the buyout package that is common in the corporate world.
One key difference between corporate employers and partnerships is that the age-discrimination laws generally do not apply to partners so a waiver-with-compensation package is unnecessary. See, e.g., David Thomas, “Court Rules Law Firm Partners Can’t Sue Under Age Bias Law, Siding With Armstrong Teasdale,” Law.com, Dec 3, 2019 (citing recent Eighth Circuit decision regarding the legality of mandatory retirement at age 70 for equity partners).
Example 3: Growth by lateral acquisition
During the 2016 presidential debates, former HP CEO Carly Fiorina boasted that HP grew dramatically during her reign, albeit without mentioning that the revenue growth was due to the acquisition of Compaq Computer Corporation. See Melinda Henneberger, “What Brought Carly Fiorina Down at HP Is Her Greatest 2016 Asset,” Bloomberg, Apr 30, 2015. Although HP did indeed grow in revenue, the acquisition proved to be a disaster from a profitability standpoint.
Similarly, law firms often trumpet their significant revenue growth even when it was due to the addition of significant lateral-partner groups. Growing a firm organically is much more difficult, often requiring partners to work together as a team over a multi-year period. As a result, most law firm managers attempt to prove their business acumen by boosting revenue through aggressive lateral hiring. They get away with it because so few partners know to ask whether profits from lateral hiring were accretive to their firm’s profits per partner.
Even assuming that lateral additions are a prudent business strategy, there is little likelihood of maintaining a cohesive culture when so many partners began their careers at different firms with very different expectations. In recent years, I’ve observed more firms entering a new market with an office beachhead that consists entirely of a collection of partners from multiple firms, without including even a single pre-acquisition partner from the firm.
Does anyone believe that the new Noah’s Ark of partners would have a unified culture that could align with the culture of the acquiring firm? So much for “we are family” with “seamless” representation across offices!
Partners in firms that grow by acquisition also foster a “my-client” culture in which partners hesitate to share exposure to “their” clients because they want to maintain the “portability” of these clients should they see an opportunity to move up the profitability pyramid.
Partners can rarely move to another firm unless they can take clients with them. Thus, partners are aware of the big payoff to be gained by hoarding clients in preparation for their “free agent” year, rather than institutionalizing their clients to become firm clients.
Example 4: Assigning credit for clients
The complexity of the methods for assigning “credit” to partners for new and existing clients has grown in direct proportion to the growth in the partners’ stakes in a firm’s profits. Historically, there have long been several seniority-based “lockstep” firms that, by dint of their high profits, have been able to ignore the topic of partner origination. However, that model is indisputably (and regrettably) on the wane. See, e.g.,”‘Lockstep’ falls out of step with modern law firms,” FT.com, Dec 16, 2021 (discussing recent changes at Linklaters and Cravath); Debra Cassens Weiss, “BigLaw firm switches from strict lockstep compensation for partners to modified system,” ABA Journal, Sept 11, 2020 (discussing changes to lockstep model at Davis Polk).
Most firms have adopted elaborate procedures for recognizing partners who generate the work while allocating separate credit to the partner(s) who do the work. As firms have gotten bigger, partners have become increasingly distrustful of any subjectivity in divvying up the profit pie. The result is a growing clamor for objective criteria. At the same time, law firm leaders invariably want to use compensation policies to guide their partners towards more desirable behaviors, such as cross-selling other offices and practice areas or focusing on more profitable types of work. The cross-currents of agendas and incentives are truly staggering.
It’s not surprising that lawyers, being lawyers, can always think of why and how the existing policy should be tweaked in their favor. What happens if more than one partner generated the work? Assuming that more than one partner is responsible for generating the work, how should the credit be allocated between or among them? What happens when a partner “inherits” a client from a departing partner? Should that lucky partner get the same credit as a partner who generates a “virgin” client?
Some firms leave it to the partners themselves to work out credit sharing when multiple partners work on the same project. I am aware of several firms where the partner responsible for a client actually “shops” a new project among potential partners in necessary specialty areas to see what portions of the credit they demand in exchange for working on the project. This is obviously contrary to a client’s interests because the partner responsible for the client is motivated to go to the partners who are in the least demand because they do not have the market power to insist upon higher percentages of the credit. Cf Jordan Furlong, “How compensation plans are wrecking law firms,” Law21, Sept 11, 2018.
The constant food fight for credit is not conducive to collaboration. See Post 188 (discussing why lawyers and law firms struggle with teamwork and citing comp plans as a major factor). You can see the culture turn when more of the lawyers start referring to clients in terms of “my” and “I” rather than “our” and “we.”
Example 5: Factory work rules
When I was a small boy in a rural area of Pennsylvania, the local farms would hire boys to pick potatoes and pay each picker based on the number of bushel baskets that he filled. Each picker would receive a stack of numbered tickets and then insert his ticket into the rim of each basket that he filled.
The practice of awarding “piecework” bonuses to associates each year reminds me of potato picking before machines took over that task. Associates often get increasing year-end bonuses as they advance through hundred-hour billable-hour levels, irrespective of the value or client acceptance of the hours worked.
Training associates to log as many hours as humanly possible cannot be in the best interests of clients, nor healthy for the lawyers and the firm. See Post 082 (discussing 60-year trendline for higher law firm billable hours). What lawyer could justify the time anymore to have lunch with colleagues? Isn’t it better to just eat at your desk? Do unplanned partner-associate mentorship lunches still exist? Is anyone surprised that the eating clubs from previous centuries have all but dried up in cities?
I have heard of some firms that are using new software apps for their associates to log in and log out as they work and take breaks during the day—not to record billable hours but to record that the associates are “in the network,” whether at their firm or home desks. This is corroborated by a recent article in Above the Law. See Jordan Rothman, “Workplace Monitoring Is Commonplace In The Legal Industry,” Above the Law, Aug 31, 2022 (discussing several examples and noting the general lack of transparency on employee monitoring).
It’s a stretch to believe that this big-brother monitoring of the “shop floor” will yield loyalty among the workers. It is more likely to result in a replay of Norma Rae.
Example 6: Treating profits per partner like earning per share
Managing to metrics is a universal business practice, but there are inevitable unfortunate consequences.
Most large law firms (i.e., the AmLaw 200) publish their financial results in The American Lawyer even though the managers of any other privately held business would rather run naked through the streets than reveal their profitability to their customers. Profit per equity partner (PPP) is the most-tracked metric of them all even though the number does not have any external meaning, in contrast to earnings per share, which is used as a trading benchmark for publicly traded companies.
Every year some excellent senior associates leave their firms because “there is no room for another partner.” What this means is that despite the investment in, and the current and potential value of, the particular senior associates, their firms are not willing to suffer a reduction in their PPP. The firms assure the senior associates that they will be happy elsewhere, particularly if they go “in-house” to clients and then refer work back to the firms that jettisoned them. (I never understood this pitch; I would have done the opposite, giving work only to lawyers who valued character and judgment more than profit.)
Lawyers rising through the ranks often face another hurdle if their firms have two or more tiers of partners, usually equity (profits-based income) and non-equity (fixed income). Unless a non-equity partner has a particular expertise that the firm needs, the non-equity partner generally has a certain number of years to move into the equity ranks. If a non-equity partner’s practice group has a leverage ratio (partners to non-partner lawyers) that falls short of the profit-maximation target, the loyal, competent, and hardworking non-equity partner often receives the same “in-house is a great life” message as the senior associates who are exiting the firm.
The arithmetic is clear—the partners in a partnership will make more money to the extent that the firm can convince the non-partner greyhounds to keep chasing the mechanical rabbit without moving them into the partnership ranks. However, the firm’s culture, as well as client relationships, often suffer when experienced and valuable lawyers need to move on in order to preserve the PPP level.
Firms can also use financial engineering to boost their equity profits per partner by demoting equity partners to the non-equity ranks. Although firms could accomplish the same bottom-line result by simply reducing the compensation paid to senior greyhounds who are no longer in the race, firms often choose instead to boost their public PPP image by sacrificing the equity status of existing partners.
Does anyone recall the well-established fiduciary duty that partners owe to other partners? See Meinhard v. Salmon, 164 NE 545, 446-47 (NY 1928) (partnership case taught to virtually every law student, noting that partners owe one another “the duty of the finest loyalty”).
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Economics was my major in college so I felt very comfortable looking at practicing law in terms of marginal revenue and marginal cost. I was also well aware that cost accounting required the allocation of firm overhead among the many business activities of the firm. I understood the importance of payback periods and ROI calculations. Therefore, I was often the “small-minded bean counter” who questioned whether the addition of a particular lateral-partner group or the opening of a new office 12 time zones away made any economic sense.
Much to my surprise, when it came to such business decisions, most law firm partners assumed that higher profits were purely a function of higher revenue.
There is no doubt that most of the efficiencies and other business-like moves discussed above have contributed significantly to the dramatic increases in profits for many law firms, but as my brother often says, “then what?”
I recall when I was a managing partner at a huge law firm that there was another large firm whose published profitability was about half of my firm’s profitability. My partners would propose at least once each year that there was a certain partner or group of partners at the lower-profit firm whom we should “poach” because they appeared to represent desirable clients. We would make our typical overtures, which sometimes led to multiple meetings, but the sought-after partners generally rebuffed our courtship even though we were willing to offer them far more money than they were making.
The partners at my firm who were doing the recruiting would be incredulous—how could they turn down the money? I always thought that this other firm must have a great culture among the partners—even their stars did not want to leave and reap the riches of their free-agent marketability.
I am not advocating for a return to the country-club style of management at law firms, but rather for an internal discussion of when enough is enough. Ideally, there should be a firm-wide income level where it is not desirable—in the name of profitability and a higher published PPP—to shed longstanding clients, practice areas, and partners, to treat lawyers like factory workers, to bicker over client credit, or to rotate free-agent partners through the firm every few years. There will always be some partners for whom enough is never enough. These partners will threaten to leave if they do not receive “market” compensation.
On this Labor Day weekend, I think I’ve accumulated enough wisdom to conclude that “feeding the beast” is not worth the hit to law firm culture. I’ll concede that practicing law was more fun before it became a business.